Investing in stocks that pay out dividends is one of the strategic ways to establish a reliable income stream and build wealth. While investors are taking on a higher degree of risk, there is also the potential for greater returns.
Finding success with these investments requires an understanding of some basic principles. We are going to explore some of the tried and true rules every savvy investor should take note of when investing in dividends.
- Stick with established companies – The stock market usually moves in cycles and has the tendency to repeat itself now and then. When choosing dividend investments, we use the stock’s past performance as the measuring stick. Investors should target those companies that have earned dividend aristocrat status. These are established companies that have increased their dividend payouts to investors consistently over the previous 25 years. Their brands are easily recognizable and they generate a steady flow of cash with a high likelihood of continuing to do so in the future.
- Choose quality over quantity – One of the most important considerations for investors is the dividend yield. The higher the yield, the better the return, but the numbers can be deceptive. If the stock’s current payout level is not sustainable over the long-term, those market-beating dividends can quickly dry up. Real estate investment trust -REITs, are a good example of how fluctuations in the market can directly affect dividend payouts.
- Look for growth potential – Investors should look at the past and present returns, and even at the company’s future potential to increase its dividend payouts. This is the primary difference between growth investing and value investing. With growth investing, rather than focusing on what the stock is trading for currently, you should look at the long-term outlook for growth to gauge how profitable it would be from a dividend standpoint.
- Mix it up – Having your stock assets concentrated in a specific sector of the market can be a good thing if the sector has a good track record that bodes well for future dividend earnings although this can be a big problem in case of a market downtown. Spreading assets out over multiple dividend-paying investments adds diversity to your holdings and it allows you to minimize risk. When dividends are reduced in one area, the loss may not be felt as deeply when the rest of your portfolio continues to perform.
- Be mindful of the payout Ratio – The Payout Ratio tells investors how much is being paid to the shareholders and also how much the company can retain. A company’s dividend payout ratio can reveal how safe the investment is. If you come across a high yield dividend stock, but the company is paying out a substantial percentage of its income to investors, that is a sign that you need to tread cautiously. If it happens that the income stream is reduced, the amount of dividends you are receiving can reduce or even be eliminated completely.
- Know when to hold and when to fold – With dividend stocks, there is a fine line between waiting for the investment to pay off and hanging on too long. Being able to recognize when a stock is sinking is vital, but you also have to know when to act on it and when to sit tight.
Dividend investing can be a reliable source of income stream that can help you build wealth. With the right approach, dividend investing can add an exponential amount of value to an investor’s portfolio. The key lies in knowing how to evaluate stocks to pinpoint those that offer the strongest returns while minimizing risk and maintaining diversity. With good use of the guidelines above, you can be able to make an informed decision when it comes to choosing the right stock with good returns and less risks.